Rotation Ahead

On the heels of a strong up week for stocks, the market cooled its jets on lower trade Friday. This is ideal market action after a surge, and suggests that soon enough, more gains lay ahead.

Adding to the bullishness, all of the indexes except for the RUT are now confirmed above their 200-day EMA for the first time in six months. This is an important development, and is the product of institutional buying, Many mistakes are made on Wall Street, but there are few accidents.

So, after such a run-up, what can possibly push this market higher? Economic data is lighter next week, earnings wildcards continue and risk of credit nightmares persist. Even if the market pulls back next week, the real source of further gains is likely to be something more simple and powerful: good old-fashioned rotation. Investors are selling bonds and commodities and buying equities, and this rotation will likely push stocks higher.

The chart below shows that the 10-year Treasury is a smoking gun behind the recent surge in equities. This was the 7th straight week that the 10-year tumbled, and it hasn't even broken critical support yet. If the Fed is almost done, expect more bond selling, with those proceeds moving into equities.





Commodities are showing increasing signs of wear, and the CRB has formed an unconfirmed double-top. This is accompanied by an expanding bouquet of negative divergences. It's worth noting that the CRB is overweight energy, and this fact distorts the breadth of commodity weakness. You can see this in the CCI chart below. The CCI is equal-weight commodities, and has already made a bearish lower high.






Because the market violated a 5-year uptrend in January, a bear market remains in play. In such an environment, stocks generally rise in jagged rhythms and rallies often end abruptly. The irony is that bear markets also produce the biggest market gains, especially as they come to an end. Unfortunately, few investors are ready when the worm turns, and so the market rises with the fewest number of investors participating.

The best tell for the market's next leg will be bonds and commodities. If selling persists in these asset classes, stocks will continue to rise.

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